Do Institutional Investors Drive Corporate Social Responsibility? International Evidence

We test for a relation between share ownership and firms’ E&S performance. It is hard to dismiss the hypothesis that E&S investments are beneficial to shareholders if they are a driving force behind firms’ E&S choices.We examine whether shareholders drive E&S performance for firms around the world, since pressure for E&S improvement is a truly global phenomenon. We specifically investigate institutional investors because these shareholders own and vote the bulk of the world’s equity capital. We construct firm-level environmental and social performance measures using line items (covering areas such as CO2 emissions, renewable energy use, human rights violations, and employment quality) from several E&S data providers. We combine these measures of firms’ E&S performance with institutional ownership data and financial data to build a sample of 3,277 non-U.S. firms from 41 countries over the 2004-2013 period.

Across these 41 countries, we find that institutional ownership is positively associated with firm-level E&S performance, with multiple tests suggesting a causal relation. For example, to support a causal interpretation, we take advantage of a quasi-natural experiment provided by the BP Deepwater Horizon oil spill in 2010. This costly environmental disaster represents an unexpected shock that increased the perceived financial value of having in place robust environmental policies and procedures, particularly for firms in extractive industries. If institutional ownership drives changes in firms’ environmental policies, then we expect that firms with greater institutional ownership at the time of the shock will be more reactive in improving environmental performance in the years following this shock. We find precisely this result.

These surprising findings matter because they demonstrate that mainstream institutional investors care about E&S issues, and actively push firms to improve their E&S performance. While one might expect activist investors, such as environmental and social impact funds, to push for such changes, we instead find that a broad range of mainstream investors do this.